Court of Appeals Warns of Red Flags for Personal Liability of Directors and Officers

Court of Appeals Warns of Red Flags for Personal Liability of Directors and Officers

Two weeks ago a federal Court of Appeals issued a decision impacting directors and officers of healthcare companies. The case involved a Pittsburgh century-old nursing home owned by a nonprofit corporation. The home began suffering losses for several years, culminating in a 2005 bankruptcy filing. A committee representing the unsecured creditors of the home then sued the directors and officers personally, arguing that management’s decision-making was so flawed that none were entitled to the protection normally given to directors and officers who act in good faith (the so-called “business judgment rule”). The Court of Appeals agreed, taking particular note of the following allegations by the creditors’ committee:

The directors continued to rely on reports from the administrator of the home, even though she was working a part-time basis only and had accumulated a string of deficiency-ridden surveys during her tenure.

The directors left the treasurer's position unfilled for a prolonged period, and failed to appoint a finance committee as called for by its bylaws. As a result, there was poor oversight of accounting staff.

The directors and officers held similar positions in a sister nonprofit, and the bankruptcy was orchestrated in a manner that benefitted the sister nonprofit.

The directors and officers should have been aware of the deepening insolvency of the home and delayed too long before filing bankruptcy.

The Court also observed that the corporate record-keeping of the home was terrible.

This case teaches that directors and officers are at risk if they rely too heavily on the business judgment rule. They must exercise reasonable diligence of their own---including assuring that the individuals reporting to them demonstrate competence in their work. Lemington Home for the Aged, 3d Cir., No. 10-4457, 9/21/11.

For more information about this decision, please contact any member of Taft's Health & Life Sciences Practice Group.